Finally, Evidence That Diversity Improves Financial Performance

This is an exceptionally thoughtful and important study about the financial benefits of diversity.

When managers and scholars talk about diversity’s impact on organizations and teams, they’re usually referring to the effects on collective accuracy and objectivity, analytical thinking, and innovativeness. On “harder” measures of financial performance, researchers have struggled to establish a causal relationship with diversity—particularly when studying large companies, where decision rights and incentives can be murky, and the effects of any given choice on, say, profits or market share can be nearly impossible to pin down.So we’ve zeroed in on diversity’s effects in the venture capital industry, which presents fewer barriers to understanding.

VC firms are fairly flat in structure, composed primarily of investment partners and relatively few junior professionals. Every investor is a decision maker, and choices have clear business consequences. We know which firms make what investments, and for the most part we can identify the individuals leading those investments, because they usually take seats on the boards of portfolio companies.

Using publicly available information, we can analyze VC professionals’ “endowed traits,” such as gender and ethnicity, and “acquired traits,” such as schooling and work history. In other words, we can see how similar or different these decision makers are and compare the quality of their decisions on the basis of their investments’ performance. Because their incentives are aligned and readily discernible—compensation for VCs is largely determined by profit sharing, ensuring that they and their investment partners have the same goals—the analysis is not clouded by inscrutable interests. The goal of every venture capital investor and firm is to choose and groom the companies that will yield the best possible outcomes.

All in all, we couldn’t have asked for a better “lab rat” than the VC world….

Venture capital firms that increased their proportion of female partner hires by 10% saw, on average, a 1.5% spike in overall fund returns each year and had 9.7% more profitable exits (an impressive figure given that only 28.8% of all VC investments have a profitable exit).

The economic impact of diversity isn’t limited to the VC world. A recent NBER analysis of highly skilled occupations (in fields such as law, medicine, science, academia, and management) shows a positive relationship between diversity and the value of goods and services produced in the United States.